Six Questions on Fannie’s ‘Mortgage Servicing’ Deal

Rep. Darrell Issa (R., Calif.) accused Fannie Mae of providing a “backdoor bailout” of Bank of America when it purchased certain mortgage assets from the Charlotte, N.C.-based lender last month.

Mr. Issa issued a press release announcing an investigation last week and fired off a letter to the regulator of Fannie Mae, the Federal Housing Finance Agency. After all, why would Fannie Mae have spent about $500 million, according to last month’s WSJ report, to buy what are known as “mortgage servicing rights” from Bank of America?

Here are six questions to help break down a complex transaction that is poorly understood:

What is mortgage servicing?

If you take out a mortgage from Wells Fargo or Citi, you’ll receive a monthly bill from that bank and mail in regular payments to Wells or Citi. But Wells and Citi don’t usually hold onto those loans after they make them. Instead, they’re often resold to a company like Fannie Mae or another firm that will package the loan with others that are then sold off to investors as securities. Wells and Citi are what’s known as mortgage servicers—middleman that collect payments from borrowers and set aside taxes and insurance premiums in escrow.

Just as Fannie doesn’t originate loans, it also doesn’t handle the day-to-day loan processing, or what is known as “servicing.” Instead, Fannie relies on hundreds of companies, but particularly a few big banks like Wells and Citi, to handle this loan servicing.

Why does mortgage servicing have value?

Wells, Citi and other servicers collect a small fee every month for all the loans they service. That means the “right” to service these loans—or the “mortgage servicing rights”—have some value to the bank. It’s an asset that can be bought and sold on the open market. Beyond that, banks can cross sell other products to customers whose mortgages they service.

What did Fannie buy from Bank of America?

Fannie didn’t buy any actual mortgages in this transaction. Instead, it bought the rights to service around $73 billion in mortgages that it already guarantees.

Why would Fannie pay Bank of America for the rights to service mortgages that it already guarantees?

Simple: to sell them to a servicer that will do a better job collecting payments. Fannie facilitated the transfer of those servicing rights—buying them from BofA in order to finance the sale to one or more specialty servicers that are specifically set up to process more troubled loans. Fannie Mae can make up the cost of the servicing transfer if the new servicers do a better job minimizing losses on those mortgages.

Since the mortgage bust, some servicers have been overwhelmed by the volume of defaulted loans, which can be harder and more expensive to manage than loans that regularly make payments. If servicers don’t do a good job servicing those loans for Fannie, that’s bad for Fannie because it may lead to bigger losses.

Mr. Issa, in his letter to the regulator that oversees Fannie, warned that the transaction shifted more risk onto Fannie. Why would that be the case?

It’s hard to see how Fannie could take on much more risk here. The company already owns the risk on these mortgages if they default. If the quality of servicing on these loans is poor, Fannie loses. (And since Fannie is being supported by massive government aid, taxpayers lose, too.)

Edward DeMarco, the acting director of the FHFA, said Monday that the “business transaction made sense for both companies” and that there was “adequate and appropriate” review of the deal.

A Fannie spokeswoman wouldn’t discuss the particulars of last month’s servicing transfer, but said in a statement, “Fannie Mae does not directly service loans but has a history of facilitating transfers of portfolios to high touch servicers in an effort to mitigate credit losses.”

Why is there political outrage over this?

Fannie and its sibling, Freddie Mac, are backed by taxpayers, and everything they do is therefore subject to extra scrutiny. This isn’t the first time that lawmakers have inveighed against a potential “backdoor” bailout of BofA courtesy Fannie.

Rep. Issa posed a dozen questions to Mr. DeMarco, but many of them miss the mark. More reasonable questions to ask regulators here might be these: Did Fannie get a fair deal when it paid to move the servicing of loans it already guarantees? Fannie has contracts with its servicers that govern how they must approach the day-to-day collection of loan payments—at what point can Fannie simply take the servicing from BofA (without inviting a lawsuit)? Were those initial contracts between Fannie and BofA (or Countrywide, which BofA acquired in 2008) written in a way that put Fannie at a disadvantage once mortgage defaults mushroomed?